Why a Currency-Hedged ETF Could Help Enhance Your Exposure to Japan

Japanese equities have climbed while the yen currency weakened, putting pressure on those exposed to Japan’s stock market. However, investors may look to currency-hedged ETF strategies that can diminish foreign exchange risks.

For example, a fund like the Deutsche X-trackers MSCI Japan Hedged Equity ETF (NYSEArca: DBJP) can help investors access Japanese equities markets while hedging against a rising U.S. dollar or weakening Japanese yen currency. The U.S. dollar has appreciated to ¥108.7 from a low of ¥105.3 back in mid-August.

A weaker yen means a lower USD-denominated return. Currency hedged ETF strategies include currency swaps to diminish the negative effects of the weaker local currency. However, potential investors should be aware that if the trends reverse or the yen appreciates against the greenback, these hedged strategies may underperform non-hedged funds.

Furthermore, another important part of the currency hedging story is the carry yield investors have achieved while hedging. Developed country currency-hedged strategies have outperformed both unhedged and local domestic stock moves. The hedged strategies not only mitigate currency moves, they also earn interest rate difference or positive carry yield between US rates and lower rates in other developed markets.

“DBJP’s hedged Japanese Yen position continues to earn carry yield for investors, at around 2.6% annualized. That’s more than we forecast the Yen could strengthen, so investors could be well positioned to maintain a Japan exposure with currency hedge. This factor means that hedging has outperformed unhedged and local Japanese stocks,” Luke Oliver, DWS Managing Director, Head of Index Investing, Americas, told ETF Trends.

Currency-hedged ETFs like DBJP can benefit from the positive carry yield between the U.S. and Japan. To put this in perspective, yields on benchmark 10-year Treasury notes were hovering around 1.76% on Wednesday, compared to the negative -0.15% yield of 10-year Japanese Government Bonds.

For more information on the Japanese markets, visit our Japan category.